In a previous article about farm business structure, we examined some key benefits of incorporating your farming business. After considering these benefits, you may have decided incorporation is right for you and are wondering about the next steps. Here, we outline some major items to consider before incorporating your farming business.
Corporate year-end
Unlike other business structures, corporations can opt for a year-end other than Dec. 31 without incurring adverse tax consequences. Choosing a non-calendar year-end may provide some significant benefits that should not be ignored.
For example, cash cropping operations may find an October year-end beneficial as crops could be sold for cash in November and December, but tax on this income would not need to be paid until the next year. Additionally, an October year-end can make it easier to ensure financial statements are ready in time to obtain financing for the following spring’s planting season. Even farms with steady monthly cash flows (such as dairy and hog operations) can benefit from an off-calendar year-end due to more tax planning options and time to implement them.
Another important consideration is the increased capacity of your accountant if the year-end is outside of their traditional busy season. While Baker Tilly firms endeavour to complete work efficiently throughout the year, delays are sometimes unavoidable during our busy season due to capacity restraints. Year-ends that fall outside of this can be completed more quickly and with more attention from our partners, managers and staff.
Incorporation date
You must also choose the date to begin reporting operations as a corporation, rather than a proprietorship or partnership. Often, a financial statement must be prepared for the period leading up to incorporation. To avoid preparing financial statements for a short tax year, it may make sense to consider delaying incorporation until your proprietorship’s or partnership’s tax year is nearly complete.
Alternatively, it may be beneficial to incorporate as soon as possible if there is a significant taxable income event approaching (for example, a higher than normal amount of inventory to sell). In this case, expediting incorporation will allow you to transfer tax liability to the corporation and avoid paying tax at higher personal rates.
Seasonal cash flows should also be considered. For example, cash crop operations often have substantial income and minimal expenses in the first few months of the year. Not taking these seasonal fluctuations into account before incorporating could expose you to a higher than expected personal tax bill.
Another thing to keep in mind when considering the date of incorporation is the taxable income from inventory can be transferred to a corporation, but accounts receivable cannot. Therefore, if you have a large amount of inventory, it could be better to postpone selling it until incorporation.
Company name
When incorporating, you can either name your company or have a numbered company. While a numbered company is slightly less expensive than a named company, it is usually advantageous from an administrative and marketing standpoint to have a named company. Keep in mind the first name you choose may be unavailable due to it already being legally registered, so be prepared with at least one other name option.
Directors and officers
A corporation must have at least one listed director. Directors are legal representatives of the company who can be held personally liable for Canada Revenue Agency (CRA) debts, including income taxes, payroll deductions and HST. Because of this liability, it may be desirable to limit the shareholders who are also named as directors.
Corporations can also choose officers who are legal representatives of the company with limited liability. There are certain advantages to having officers, such as giving family members authority to act on the company’s behalf for daily banking. Accordingly, you may wish to consider your spouse or children as officers.
Types of shares
The two most common types of shares issued by corporations are special shares and common shares.
Special shares are often issued to represent the value of equity you are transferring from the partnership or proprietorship to the corporation. This value remains fixed unless shares are redeemed by shareholders.
Common shares, sometimes called growth shares, represent the value of the company from the date of incorporation onwards. It is possible to issue a separate class of common shares for each shareholder. Having various common share classes increases flexibility in allocating dividends to optimize tax planning.
Your Baker Tilly advisor can help determine which of these shares would work best for your business.
Assets and liabilities at incorporation date
To properly document the transfer of assets from a partnership or proprietorship to a corporation, your advisor requires a complete list of assets and liabilities as of the incorporation date. This includes cash, accounts receivable, prepaid expenses, inventory, land, quotas, equipment, investments, accounts payable and loans.
Usually, your advisor will also need to know the current fair market value (FMV) of each asset and liability. Ideally, they would review statements supporting more significant balances, such as bank statements, invoices and loan statements. For real estate, your advisor would require information on the cost, year of purchase and estimated FMV with a breakdown of the value allocated to land, buildings and houses. An appraisal should be done to support values used.
For marketing quotas, your advisor would require details on the year each quota unit was purchased, the amount of cumulative eligible capital (CEC) or capital cost allowance (CCA) claimed each year since inception (depreciation taken on the quota for tax purposes), the historical cost of the quota and its current FMV. Your advisor would also need to be aware of the history of any quota obtained from family members for less than FMV.
Transferring land and marketing quotas to the company
It is not always necessary or desirable to transfer all proprietorship or partnership assets to your company. This applies particularly to land, homes and marketing quotas. If land or marketing quotas are transferred to the company, you will have less flexibility in transferring these assets to the next generation at less than FMV. It will also be more difficult to access your capital gains exemption when selling these assets in the future.
Additionally, choosing to claim your lifetime capital gains exemption on the transfer of these assets to the company could have a significant immediate impact on your personal income tax (including refundable alternative minimum tax) and the social benefits you receive, such as the Canada Child Benefit. If you transfer your personal home to the corporation, you will lose your principal residence exemption from the future capital gains and be subject to a personal taxable benefit for the use of corporate-owned property.
Despite these negative consequences, you may still wish to transfer these assets to the company for a variety of reasons. For example, if you have debt you want to transfer to the corporation, you will need to transfer enough assets to be able to assume this debt. Additionally, the negative consequences may not be significant in situations where you have maximized your capital gains exemption or have no intention to transfer assets to different successors.
Conclusion
The above article summarizes just a few planning items to consider before incorporating a farm business. We recommend you work with a professional, such as your Baker Tilly advisor, to provide further assistance related to your situation. Next, we will take a look at what to consider after the company is incorporated.
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